By Russell Rhoads,
head of research
Each year, in late June, FTSE Russell conducts a major realignment of their family of equity indices. Last year it went off without a hitch in the middle of the pandemic as in 2020. The completion of last year’s reconstitution saw over USD125 billion in crossing trades executed on the closing bell at the NYSE and Nasdaq. Five years ago, the night before the reconstitution trades, the world was surprised by the outcome of the Brexit referendum, the stock market reacted with a very volatile day, and again the reconstitution process went off without a hitch. There is no reason to think this Friday will be any different from previous FTSE Russell reconstitution days.
FTSE Russell begins the process behind updating their equity indices in early May when all eligible US companies are ranked based on market capitalization. This year that was on May 7. Anyone with access to market data can replicate the process FTSE Russell undertakes to rank these companies. On June 4 the preliminary additions and deletions to the various FTSE Russell indices were shared with the public and throughout the course of June this list could be slightly altered based on more analytical work, but the June 4 announcement is a pretty solid indication as to what changes will be made to the indices.
When most market participants think of the FTSE Russell indices they think of the Russell 2000 and the reconstitution of this index often receives the most attention. The Russell 2000 is considered the benchmark for small cap managers, hence the attention on any index changes. Also, the iShares Russell 2000 ETF (IWM) alone has about USD70 billion in assets under management and this fund will be buying and selling shares to maintain exposure to the Russell 2000.
A clear indication that the market takes this process in stride shows up in the implied volatility of options on the Russell 2000. The Russell 2000 Volatility Index (RVX) long term average is 24.21. However, the average for RVX during the month of June is 23.98 and June ranks seven out of twelve with respect to monthly averages (chart below). Expected volatility is not elevated in June relative to other months because the market is certain this will be a smooth process.
Data Sources: Cboe Global Markets / EQD Research Calculations
Annually, I see market observers talk about taking advantage of the change by buying the additions to the Russell 2000 before the date that the stocks become members of the index. Admittedly it is one of the higher volume days each year as on reconstitution date there will be a massive number of shares traded on the close of the market. These crossing trades happen in the blink of an eye and constitute over a billion shares changing hands. This liquidity event runs so smoothly that the only way most market participants even know it happened is when the stock market volume figures jump in the last seconds of trading. The point is this excess volume is not an opportunity for traders to game the system, it is an orderly process that creates volume, but not volatility.
All FTSE Russell reconstitution information may be found here – Russell Reconstitution